What is The New Spending Bill and What is in it?
Last Thursday evening a massive $1.5 trillion dollar spending bill was passed by the senate after months of negotiating which included three stopgap bills that funded the government in the meantime. This bill is the first major spending legislation by the Biden administration and included substantial increases for domestic and national security programs by roughly a 6% increase from the prior year (Lobosco, Luhby 2022). Fiscal expansion policy has always been a hard point of negotiation between Democrats and Republicans mainly due to disagreements on where federal funds should go and how much should be spent on given programs. The two were able to meet in the middle as Republicans negotiated a $42 B increase in military spending and Democrats negotiated a $46 B increase in domestic programs. The increase in spending potentially could have been much more than 6%, but Republicans pushed that no further funds would be allocated to COVID response efforts, and so $15.6B was dropped from the bill that would have been allocated to such (Cochrane 2022). This suggests that the government spending is starting to look more like it did pre pandemic with more spending on the usual defense and domestic programs rather than allocating any more funds to COVID related responses.
Fiscal Policy: In Recessions Past
It is first important to understand why fiscal expansion policy is used, what it seeks to accomplish, and how it works in revamping an economy. In an article from Dr. Linas Čekanavčiusi, professor of Economics at Vilnius University in Lithuania, he explains that “The idea is that during the recession the best way to stop a downslide and to induce recovery is to pour money into the economy…” (Čekanavčiusi 2018). He stresses the importance of fiscal policy as he references the Keynesian conclusion that when interest rates are already low the economy will remain in decline with monetary policy alone and it requires the government to increase its spending. The Keynesian thought here is that the government is the most efficient player in “allocating idle resources” in a recession. Fiscal stimulus helps increase demand and then pulls up the supply side of the economy which promotes more jobs to balance with the higher demand. Dr. Čekanavčiusi points to the New Deal in the United States as well as Sweden’s policies implemented during the Great Depression. FDR’s New Deal included massive public works programs that was followed by massive military spending in WWII that boosted the U.S economy. The Swedish government in 1933 started programs that funded public works as well as support to the agriculture sector. The Swedish were able to recover their economy much faster than other countries and by 1936 they had returned to pre-depression numbers for both their level of production and real wages. Čekanavčiusi warns that there are many factors that impact the effectiveness of these policies including the timing and the sustainability. A country must be able to finance the new debt they take on at a reasonable rate or they risk falling into crisis again. (Čekanavčiusi 2018)
Connecting the Dots: IS-LM and COVID Era Policy
Now we can take a look at the spending bill and other COVID fiscal policy and how the mechanisms of fiscal policy fit into the IS-LM model. In 2020, the Federal Reserve responded to the COVID crisis and used a variety of monetary tools to prevent the economy from plunging into what could have been a historic recession. This was accompanied by fiscal policy including the CARES Act that came from congress that also stimulated output. Using the IS-LM model we know that both the 2020 fiscal and monetary policies work in the same direction and increase output, producing the similar results we saw from fiscal policy like the New Deal. The increase in government spending increases the demand side of our IS relation and in response firms will match that on the supply side. On our IS-LM model this would be shown by shifting the IS curve to the right resulting in an increase in equilibrium Y. On the monetary side, the lower interest rates make it cheaper and easier for firms to expand and grow, especially as they need to produce more. As in the previous paragraph, since the interest rates are already so low, fiscal policy is the largest player in keeping the economy afloat and avoiding recession. On our IS-LM model, this would be shown by shifting the LM curve down. This is an example of policies moving in the same direction, but now in 2022 we are seeing something slightly different policy wise.
We see the same increase on the demand side of the IS relation with the 2022 bill, as government spending increased by 6%. Just as in 2020, recovery is being induced by pumping money into the economy, which should increase employment and GDP. With this new bill we should again see a shift in the IS curve to the right. This is key for increasing output since interest rates are already incredibly low and we wish to avoid a liquidity trap. This however looks to be coming to an end since the Fed is looking to hike up interest rates which would mean using policies that work in opposite directions. The idea is to reduce the budget deficit created from the 2020 spending, but not reduce demand enough to push the economy into recession. This covers what Čekanavčiusi mentions as that the government must be able to handle their debt and finance it accordingly. So in terms of our IS-LM Model we would see a shift of the IS curve to right for fiscal expansion and the LM curve shift up for monetary contraction. The rise in interest rates helps get the debt under a little more control while still keeping the economy healthy. Based on the numbers from policy implemented in 2020 and looking back to the Great Depression area fiscal policy use, it is easy to see that this spending bill will help induce the economy to full recovery and what we hope to be the end of the COVID crisis. We should expect to see an increase in output as we did from the 2020 policies. But we will also see a slow down to a more stable rate due to upcoming monetary policy. All in all, we can hope to see our economy back to pre-COVID performance after a long and difficult two years.
See Supplemental Graphs and Visuals Below
The breakdown of spending. Largest area going to DOD
FRED Graphs
As we discussed in the third paragraph, the US government used fiscal policy at the start of the pandemic to prevent a historic recesion. In our first graph showing the federal surplus/deficit, we see the steep increase in the deficit at the start of the pandemic where we threw everything we had into the economy to keep it afloat. We also see the deficit increase during the 2008 crisis where we know the government poured massive amounts of money into the banking industry. In the second graph we see the evidence of budget deficits at the end of the Great Depression and a huge deficit with the onset of WWII. All these deficits represent the use of huge fiscal policy to save a sinking economy. Looking at the third graph the percent change in government surplus/deficit is graphically represented. We see spikes in deficit during the Great Depression and most of WWII. As we discussed in the blog, these fiscal policies greatly increased the deficit but were what brought the economy back to health. Hopefully just like after the other recessions we see a decrease in our deficit and we return to normal.
We know that the 2020 policies worked by looking at the final graph. We see GDP and its sharp drop in the early months of the pandemic, but then see that GDP took a sharp turn for the better and now is on a more steady incline to normal numbers. The 2022 bill and upcoming monetary policies will look to put the finishing touches on getting the economy back to normal.
No comments:
Post a Comment